Why Oil Shocks Hit The U.S. Economy Differently Than 20 Years Ago

The US-Israel war with Iran has triggered the largest oil supply disruption in recent history. Oil prices

recent history. Oil prices have been extremely volatile since this conflict began.

Analysts are tracking the reduction in oil output in the Gulf, speculating that a sustained supply shock could push crude back toward triple digit territory.

Americans are already seeing this pressure at the pump.

The average price per gallon of unleaded gas in the US surpassed $3.50 on Tuesday, the highest level since 2024. The last time the US

2024. The last time the US entered a major war in the Middle East was the 2003 war with Iraq, and oil prices climbed sharply in the years that followed. But this

that followed. But this economic moment isn't a carbon copy of the Iraq war era. Here's what,

era. Here's what, if anything, the Iraq war can tell us about how the current conflict in Iran will impact the US economy.

Energy volatility is one of the earliest ways consumers feel the economic impacts of any military action in the Gulf. During the years

Gulf. During the years following the Iraq war, global oil prices rose sharply. Oil climbs from

sharply. Oil climbs from around $30 per barrel in 2003 to more than $130 by mid-2008.

And by 2008, the national average for a gallon of gas had more than quadrupled from 2003 levels.

The war in Iraq is going to remind a lot of people of past times that the United States got involved in military conflicts and other kinds of conflicts that spiked the price of oil in the 1970s for the oil embargoes. Or we can look at

embargoes. Or we can look at the Iraq War in the 1990s.

Those were episodes that sent the price of oil way, way, way, way up.

And, in fact, the price of oil in those moments rose significantly more than it is right now. And that's

because the United States produces a lot more oil than it used to.

But, unlike 2003, the US is now the world's largest oil producer.

That doesn't make us immune to global shocks. Oil is

priced globally. But it does mean the macro impact is less one sided than in past oil crises.

Oil prices affect inflation in two ways.

First of all, there's just the direct price you pay at the pump when oil gets more expensive. You know, we make

expensive. You know, we make gasoline out of oil.

And so when the price of oil goes up, then gasoline gets more expensive. The second

more expensive. The second way is a little more indirect. When oil gets more

indirect. When oil gets more expensive, lots of other stuff gets more expensive in the economy. You know, if

the economy. You know, if your home is heated by oil, that gets a little more expensive. You know, if your

expensive. You know, if your business is heated by oil and you sell stuff, then that's a business cost for you.

Higher oil prices leading to inflation is only part of the story. Interest rates

the story. Interest rates will also directly affect household budgets.

In 2003, the US economy was emerging from recession and inflation was low.

The Federal Reserve's target interest rate was around 1%.

Over the past few years, inflation has remained above the Fed's 2% target, and interest rates are still elevated compared with past environments post financial crisis. That can change how

crisis. That can change how markets react to something like war driven oil spikes.

It's hard to compare the two wars: the Iraq War in 2003 compared to what we're doing in Iraq now. The American

economy was in a much different place than it is now. Back then,

now. Back then, we were coming out of a recession. We were coming

recession. We were coming out of the dotcom bubble, the 9/11 attacks, and a stock market that was kind of taking a beating as well. So we had very low

well. So we had very low inflation. In fact, the

inflation. In fact, the concern then was that inflation was too low and that Federal Reserve officials were kind of trying to gin inflation up a little bit to where it considered a healthy level that was congruent with a healthy economic growth.

This time around, we have stubbornly high inflation. We have high

inflation. We have high interest rates and a very different economic backdrop that's going to pose very different economic challenges.

When people think about interest rates, they mostly think about things like their mortgage, their car payment, their credit card bills.

Those are not interest rates that the Fed affects directly. Those are set by

directly. Those are set by the market, and they tend to follow something called the 10-year Treasury.

Since the conflict began, that benchmark yield has risen. This can have a

risen. This can have a significant impact for the average American.

Eleven percent of disposable income for the average US household goes toward required debt payments, including things like mortgages and credit cards.

Investors are looking out there and saying we think there's going to be more inflation because of this war. You know, the price of

war. You know, the price of oil directly makes everything more expensive.

Investors also think that it is going to make the Fed less likely to cut interest rates in the next couple of months under its current chair, Jerome Powell. So

those factors are keeping the Treasury yield relatively high. One thing

relatively high. One thing that we're not seeing, which is kind of curious, is that sometimes in moments of big global chaos, you see investors buy up a lot of US treasuries, which pushes down their yields because they're worried about the state of the world. And nothing is

the world. And nothing is safer than an investment backed by the full faith and credit of the US government.

It speaks to a worry people have that global investors are starting not to trust the US government as a really safe place to put their money, because the deficit is very high, because debts are high and also because they have worries about the current president.

The market's kind of in control here. Its ability to

control here. Its ability to influence things in these types of situations is a little bit constrained.

Monetary policy is not intended to deal with wars.

Even if the Fed does cut here, that doesn't mean that rates will come down.

It doesn't mean that Treasury yields will come down. And we've seen that

down. And we've seen that within the market already that there are very different, very unique forces that come into play here that the Fed doesn't necessarily have control over.

Another factor with elevated Treasury yields is it will make servicing federal debt more expensive.

The Iraq and Afghanistan wars added trillions to the national debt over time and widened deficits during the 2000, which begs the question of how much a new conflict will cost.

This war will probably cost us something and will probably affect the deficit, but it's relatively small in the grand scheme of how much money the federal government spends.

The war is almost certain to add to the deficit. The way

lawmakers in the White House approach war costs, as if they're separate and above general fund type of expenses. So you're not

expenses. So you're not really thinking about paying for these expenses with revenue or anything like that. They're sort of a

that. They're sort of a beast amongst themselves.

On top of the cost for servicing the debt, there's also what economists call opportunity cost.

Opportunity cost is just basically taking resources from one place and putting them somewhere else.

So in this current instance, the opportunity cost would be where you could be focusing on spending money on things that you want to get done domestically.

Instead, you're taking those resources and you're diverting them.

And they're not just fiscal resources. There are

resources. There are intellectual resources, those type of things that are diverting elsewhere now.

So the agenda at home takes a back seat. The agenda

abroad comes to the forefront, and that's your opportunity cost.